A frequently-asked question is whether a
mortgage borrower receives any benefit from paying before the due date.
In most cases, the answer is “no”, but there are a few exceptions. With
simple interest mortgages, including HELOCs, it does
pay to pay early and, under some circumstances, paying early in order to
shift next year’s interest into this year could reduce taxes.

The Rules When Payments Are Late

On a standard monthly payment mortgage,
the payment is due on the first day of the month, and will be credited
to the borrower on that day, regardless of when it is received. If the
payment is received within the grace period, customarily the first 10 or
15 days, the borrower receives a free ride – no interest accrual – for
those days. If the payment is received after the grace period but within
the month, the borrower is subject to a late charge. If the payment is
not received until the following month, the borrower incurs a late
charge and is reported to the credit bureaus as a 30-day delinquency,
but the payment is credited as of the first day of the previous month.

When Payments Are Early

Payments made before the due date are
also credited as of that date. This gives the lender free use of the
borrower’s money for that period. The borrower who consistently pays two
weeks early, for example, is in effect providing the
lender with a two-week grace period comparable to that provided
by the lender to borrowers who pay late. There is no benefit to the
borrower.

Simple Interest Mortgages Are Different

On simple interest mortgages, interest
accrues daily rather than monthly, which changes the rules
significantly. As with standard mortgages, payments are due on the first
day of the month and late fees are charged on payments received after
the grace period. On simple interest mortgages, however, interest is due
every day. This means that a borrower who pays one day late pays
additional interest for that day, and the borrower who pays one day
early saves a day’s interest.

The bottom line is that a borrower who
consistently pays 2 weeks early will save money on a simple interest
mortgage. That doesn’t bother the lenders because they know that those
are rare birds. Most borrowers pay late.

Borrowers don’t get to choose between
standard and simple interest mortgages; I have never heard of it being
offered as an option. Most have standard mortgages, and those with
simple interest mortgages typically didn’t know what they were getting.
Borrowers need to adapt their payment habits to the kind of mortgage
that they have.

I should note that HELOCs are simple
interest and most HELOC borrowers do understand that
they accrue interest daily. It pays to pay early on a HELOC.

Making Advance Provision For Future Payment

Early payment should not be confused
with making advance provision for future payments. When I took my family
on an around-the-world tour some time ago, I left a set of checks with
the loan servicer dated at monthly intervals. This assured that each
payment would be made on time, but I was not giving the servicer the use
of my money because only one check at a time became negotiable.

A Potential Tax Benefit in Paying Early

In December, some borrowers who itemize
their deductions make their payments for the early months of the
following year. This shifts the interest deduction in those months from
next year to this year. This can be especially advantageous if the
borrower expects to be in a lower tax bracket, or expects the tax rate
to be lower, next year.

For this to work,
however, you need the servicer to agree in advance to credit your
account this year for the payments due next year. The end-of-year
statement will then show the interest as having been paid this year.

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